new kid on the block - peterrayney.co.uk

1 N corporate 3030303030march 2015 accountancy Company reconstructions and demergers for owner-managed companies seem to be particularly in vogue at the moment. A number of these cases involve the separation of trading and property investment activities carried on by the same company or group. Typically, the main objective will be to place the property investment and trading activities into separate entities. This often enables a valuable property investment portfolio to be insulated from trading risks and may also bring inheritance tax (IHT) advantages for the split of the separate business activities is usually achieved via a corporate demerger - the end result being that the trading and investment activities are run through separate companies owned by the same shareholder(s) or different groups of shareholder(s) from the original company.

2 Planning a corPorate demergerWithout special relieving provisions, such arrangements could trigger significant tax liabilities for both the company and its shareholders. The distribution of the businesses to the shareholders would result in the (original) transferor company being charged tax on gains attributable to goodwill and properties, etc (deemed to be disposed of at their market value). Furthermore, the recipient shareholders would also be taxed on the market value of the assets received by them, as income distributions. However, using the special corporate and shareholder reconstruction reliefs, it should normally be possible to split or demerge the relevant business activities on a tax-neutral basis.

3 In some cases, there may be an unavoidable stamp duty or stamp duty land tax (SDLT) of the most important requirements for any demerger is the need to avoid a taxable distribution arising in the shareholders hands. Traditionally, this has been achieved by:QQa liquidation/non-statutory demerger under section 110 Insolvency Act 1986 (IA 1986) since a distribution made in the course of a winding-up is not an income distribution It pays to structure corporate demergers under the relaxed capital reduction rules to take advantage of tax reliefs, says Peter Rayneynew kid on the blockit will normally be possible for a demerger equal to part of that value to be made as a return of capital to the accountancy march 2015 3131313131corporate demergers n avoiding the potential problems associated with liquidations and so on.

4 Furthermore, because of the need to remove all assets from the liquidated company, a capital reduction-based demerger is often simpler and can often be planned to save SDLT reduction of capital (which also extends to share premium accounts) can now be implemented fairly easily. It requires a special resolution made by the shareholders. Within the 15-day period before the resolution, the directors must support the capital reduction by providing a solvency statement complying with s 643, CA 2006. The solvency statement, which must be approved by each director, confirms that: QQthere are no grounds for the company being unable to pay its debts now and over the next 12 months; and QQthat any winding-up of the company within 12 months would be a solvent , there is no requirement for a supporting statement from the company s auditors.

5 However, it may be useful for the company s accountants to prepare/review a suitable cashflow statement. After the special resolution is passed, the company must (within 15 days) send the Registrar of Companies:QQa copy of the special resolution;QQthe solvency statement; andQQa statement of capital. The statement of capital reflects the company s share capital after the reduction has taken distribution for tax PurPosesUnder a capital reduction demerger, no distribution arises for tax purposes. This is because the shareholders receipt of the shares in the demerged company represents a return of their original share capital (s1000 (1)B)(a), CTA 2010).

6 Clearly, this technique only works where the shareholders have subscribed a sufficient amount for their shares in the distributing company to frank the demerger transaction. Where this is not the case, it is possible to create significant share capital by implementing a company reorganisation. A capital reduction demerger is, therefore, often preceded by a share exchange transaction, which involves the creation of a new holding company (Holdco). The shareholders of the existing company exchange their original shareholdings for new shares issued by Holdco. The tax and legal analysis here is as follows:QQFrom a CGT perspective, the new Holdco shares received by the shareholders take the place of their original shareholdings (assuming HMRC accepts that the share exchange is driven by commercial reasons).

7 This 32(s1030, Corporation Tax Act (CTA) 2010); orQQa statutory demerger within chapter 5, part 23, CTA 2010 this legislation provides that demergers satisfying the relevant conditions are not treated as distributions. It is necessary to ensure that a statutory demerger distribution of a (75% plus) subsidiary or trade is legally compliant, since the distributing company must have sufficient distributable reserves to frank the demerger distribution (in the same way as any other dividend). The statutory demerger code cannot be used to separate investment and trading activities, since it only applies to trading companies or groups.

8 Thus, such cases have always been dealt with using a liquidation/non-statutory demerger under s110, IA 1986, which involves liquidating the company and incurring costs relating to the winding-up. Understandably, some owner managers freak out at the prospect of such technical liquidations even though steps can be taken to distance the company/business from the winding-up and associated public disclosure. caPital reduction demergersThe Companies Act 2006 (CA 2006) significantly relaxed the rules enabling private companies to reduce their share capital. In recent years, it was recognised that these provisions can be used to implement corporate demergers, thus n corporate 3232323232march 2015 accountancy treatment is often referred to since the shareholders have legally disposed of their shares;QQIn reality, the shareholders have subscribed for their new shares in Holdco at the (full sale) value of the shares they held in the original company.

9 In other words, they have acquired the shares in Holdco at an amount equal to the market value of the original company. If the share exchange were accounted for under merger accounting principles, this value would not be recognised in the Holdco s accounts. However, the sale contract would state that Holdco had acquired the original company at market value, and this also represents the shareholders subscription price for their new Holdco subscription value of the Holdco shares represents the market value of the acquired company. Consequently, it will normally be possible for a subsequent demerger equal to part of that value to be made as a return of capital to the shareholders (ie, not out of Holdco s distributable reserves).

10 Practical experience suggests that HMRC is satisfied with capital reduction demergers, provided they are properly implemented. tax reorganisation rules A reduction of capital simply provides protection from an income distribution charge. Reliance must still be placed on the usual tax reconstruction reliefs to avoid a capital gains charge at both the corporate and shareholder levels:QQs139, TCGA 1992 effectively prevents the company from incurring taxable gains on the relevant chargeable assets passing with the business, by deeming them to be transferred Case study return of Capital demergerNeil has decided that he would prefer to retire from the steel business and take over the property investment business.